Posts Tagged ‘low-skill unemployment’

The wage is too damn high?

19 February 2013

I don’t think so. But first, some background.

President Obama proposed raising the minimum wage in his State of the Union address. Specifically he called for it to go up to $9 an hour by the end of 2015, up from $7.25 now, and then to index it to the rate of inflation in subsequent years. Is this a good idea?

Economists are famous for being against the minimum wage, with introductory microeconomics textbooks typically using it as an example of a price floor that creates a surplus of the good in question – in this case, a surplus of labor, or unemployment. And that is valid if the market for labor is perfectly competitive and if the rest of the economy is held constant. (Two rather big ifs, yes.) Economists call this “partial equilibrium analysis,” as opposed to “general equilibrium analysis,” which looks at the repercussions in all markets. In the economy as a whole, firms can’t always sell all they want to at the going price, and too-high wages are not the only source of unemployment – recessions cause unemployment, and so does falling demand in specific sectors of the economy. It’s also possible that higher minimum wages could increase the total income of the lowest-paid workers, resulting in more demand for goods and services in general and a higher level of employment. The White House clearly believes that last part (more about that here).

Who’s right? It all depends on which effect is stronger – the micro effect (higher wages mean less output and employment) or the macro effect (higher wages mean higher incomes and higher aggregate demand). And that is an empirical question. For decades, most economic studies found that minimum wages reduced employment among the least educated, least skilled workers, i.e., the people most likely to be working at low wages. But an influential study by economists David Card & Alan Krueger in the 1990s found either no effect or, surprisingly, a positive effect of higher minimum wages on low-skill or teenage employment. In their 1995 book, Card & Krueger further found that the earlier studies omitted important variables, like teenage high school attendance rates, and that controlling for those variables caused the minimum wage’s estimated effect to be insignificant. Their work has had its own critics and would-be debunkers, but it remains influential.